Definition

The term changes in accounting estimates referrers to those estimations that require revision based on the availability of new and better information in the current accounting period. Changes in accounting estimates can involve revenues, expenses, liabilities and assets; and are corrected prospectively in the financial statements of a company.

Explanation

Also known as normal, recurring corrections and adjustments, changes in accounting estimates occur when better information becomes available. Accountants as well as business specialists are required to estimate expenses and revenues in addition to the value of assets and liabilities appearing in the financial statements of the company. The change in the useful life of an asset, bad debt, pension obligations, and inventory values are some examples of estimates that can materially affect the income statement or balance sheet.

Changes in accounting estimates is one of several categories of irregular items that may appear as line items or notes to one or more of the company's financial statements. Unlike errors that require prior period adjustments, corrections to these estimates are made prospectively if better information is available; this means such changes can impact both the current as well as future accounting periods. In addition to not being considered an error, a change to an estimate does not meet the definition of an extraordinary item.

Example

Company A purchased a machine for $200,000 with a useful life estimated at ten years and no residual value. In Year 7, it was determine the machine needed to be replaced in Year 8. Company A used straight line depreciation of $20,000 per year in Years 1 through 6. To account for this change in the estimated useful life of the asset, Company A would depreciate the balance of the asset's value in Year 7 and 8 as shown below: